Mommy, Why Do Revenues Grow?
May 15th, 2008 . by economistmomWell, they grow for lots of reasons, but mostly they grow because the economy grows…
I said I was going to post on this subject, and I thought I’d have to tell a long story, but lo and behold, I discovered CBO has already told this story very recently, in this report that I only noticed when going to their site to look up the historical data.
If you look at the historical data on revenues, you’ll notice that revenues almost always grow, in current dollar terms, because the economy almost always grows in current dollar terms. In the 40 years that CBO’s historical data spans (1968-2007), total federal revenues, and individual tax revenues, only decreased two times, prior to the Bush Administration tax cuts: in 1971 and in 1983. Revenues decreased continuously in current dollar terms in 2001, 2002, and 2003. Some folks point to the subsequent nominal revenue rise in 2004 on, as proof that tax cuts pay for themselves: they say capital gains and dividend tax rates were cut, and revenues rose. Well, no, revenues grew in 2004-07 because the economy grew–as is most of the explanation throughout history. (This is a correlation without causation; perhaps I could say that my growing older caused revenues to rise, too.)
And CBO’s report shows that the fact that the economy grew (at least a little) had little to do with the tax cuts. It’s easy for the economy to grow in nominal terms, and in fact, economists view nominal growth as pretty meaningless. What really matters is real growth in the economy, and when the economy is growing strongly enough to keep ahead of inflation, well, now you’re really talking helpful in terms of revenue growth–because then revenues even relative to the size of the economy (revenues/GDP) grow. Revenues grow especially fast if taxable personal incomes keep ahead of growth in the overall economy. Revenues also grow more strongly when the distribution of income becomes more skewed, and yes, revenue levels can increase and decrease with tax legislation (changes in tax bases and rates), although not in the directions often claimed.
So on this more meaningful, “why do revenues as a share of GDP grow?” question, it turns out that the Bush tax cuts didn’t grow revenue at all, because the economy and taxable incomes haven’t been growing that strongly in real terms. The whole premise of the CBO study was to focus on the 1994-2004 period and determine why individual tax revenues as a share of GDP rose so dramatically in the 1994-2000 period, then fell so sharply in the 2000-2004 period. (See the cover of the CBO report for the picture.) To quote from their summary:
Those changes in individual income tax revenues relative to the economy present a complicated story. The key factors include:
Understanding those forces is critical to projecting the future path of federal revenues.
Note that CBO says that tax legislation “…was a major factor in the decline in income taxes relative to GDP from 2000 to 2004″. This is consistent with the way in which the Bush Administration has habitually bragged about the merits of their tax cuts in their Economic Reports of the President –based on how much revenue they have lost (or rather, “given back to the people”) and not on how much economic growth they’ve produced.
So for readers interested in the tax cuts and economic growth issue, please read this CBO report (”Sources of the Growth and Decline in Individual Income Tax Revenues Since 1994″), check out the historical data on revenues, and let us know what you think.
Hmmmm…lots to think about but a few observations.
Wasn’t there an event, like 9/11, that might have had an effect upon economic growth during the 2000-2004 timeframe? Could the Bush tax cuts helped offset that “economic” shock?
And why just look at the effect of tax cuts since 1994? Didn’t Reagan cut marginal rates drastically in the 80’s ? Yes, they have gone up (but not all the way up to the 70’s levels) from the Bush1 and Clinton tax hikes. By the way, didn’t a recession follow the Bush1 tax hike? Didn’t the 1st two years of the Clinton term result in sluggish growth? I thought the capital gains cut occurred in 1994 which is when economic growth took off. And didn’t Greenspan flood the market with dollars for Y2k that may have spiked growth late in the 80’s?
In general, since the Reagan tax cuts, we have had real economic growth, increased employment and real tax revenue growth. If spending had been simply capped at inflation, we would not be talking deficts now. Actually, we did have reduced spending under Clinton, at the expense of the most important function of government, defense. So we did have surpluses as a result (not necessarily a good thing, I would contend).
I thought the capital gains cut occurred in 1994 which is when economic growth took off.
No, if you look at page 13 in the Treasury document at http://www.ustreas.gov/offices/tax-policy/library/ota81.pdf , you’ll see that the capital gains cut occurred in 1997. However, note which tax bill did occur in 1993, just before “economic growth took off”. It was the Omnibus Budget Reconciliation Act of 1993 which raised the top marginal rate to 39.6 percent.
So, as I asked you at http://economistmom.com/2008/05/fiscally-responsible-tax-cuts/#comment-28 , please tell me any specific numbers or conclusions in my analysis at http://home.att.net/~rdavis2/taxcuts.html that you disagree with. Of course, I know that not everyone has the time or inclination to check my calculations. So alternately, please post a link to one serious economic study that purports to show evidence of any income tax cut that has ever paid for itself. As I said, I am open to any real evidence. But until someone shows me that evidence, I’ll just have to stick with the numbers and every economic study that I’ve read on the subject.
Let’s see, Reagan cut taxes and the national debt tripled during his time in office. Bush II cut taxes and the national debt has nearly doubled during his term. Clinton raised taxes and the national debt actually decreased for a short period of time. This evidence seems to support the argument by Ms. Davis. When Bush II took office, we were running an annual budget surplus – although the national debt was still huge – so he proposed a tax cut in order to send some of this surplus money back to the people. A few years later, when the economy went sour, he proposed another tax cut to help us grow our way out of the slow economy. It seems that tax cuts are the answer to every situation. I wonder if there ever is a justification for a tax increase, say something like a 5-year war costing nearly a trillion dollars, all of it borrowed and placed on our children’s bill? No, not even that justifies a tax increase in the eyes of the true supply-side believers. No one but our soldiers and their families are supposed to sacrifice anything for the “all important war”. If I wasn’t living this, I wouldn’t believe it.
Diane,
Great post! For quite a while I have been trying to slay the myth that “tax cuts increase revenues” (for tax cuts in individual labor and investment income from starting points anywhere close to current or recent historical tax rates).
Those who perpetuate this myth usually just cherry-pick revenue data and say that “revenues have increased following tax cuts every time”. Of course, they wouldn’t pass Correlation Analysis 101 because they don’t consider what happens to revenues absent tax cuts, which is the mistake you expose so well in this post.
FYI, I’ve compiled an extensive collection of quotes from conservative economists — including Bush’s own current and former top economists — saying that the Bush tax cuts, and tax cuts generally, have a substantial net negative impact on revenues. See http://logicizer.blogtownhall.com/2007/11/15/no,_the_bush_tax_cuts_have_not_generated_higher_revenues.thtml
I also created a table to illustrate why, as tax rates get lower and lower, tax cuts from those starting points become less and less likely to generate enough incremental growth in the tax base to reach revenue-neutrality. See http://logicizer.blogtownhall.com/2007/10/20/the_logic_of_the_laffer_curve.thtml
Drew said:
This evidence seems to support the argument by Ms. Davis.
Thanks for the support. By the way, it’s Mr. Davis. I know that the “B” is a bit ambiguous! In any case, I am likewise bothered by the fact that we are asking so much from our soldiers and their families and absolutely nothing from other citizens. It must be appealing to think that tax cuts are increasing revenues and thereby adding to the war effort. Nevermind that every serious economic study that’s been done (that I’m aware of) says otherwise. What has long amazed me, however, is how many supply-siders there are who seem completely unbothered by this lack of evidence. I have to wonder if many of them don’t have other agendas.
I find it interesting that every official document from the Bush administration that addresses the issue has estimated that the tax cuts have brought in less revenues over whatever period is in question. For example, Table 7 in the 2005 Mid-Session Review breaks down the increase of over $2 trillion in the deficit since the 2002 Budget. It states that 49 percent of this swing was due to reestimates, 29 percent was due to tax relief, and the remaining 22 percent was due to the war, homeland, and other spending.
I also found it interesting when, at the request of the Senate Committee on Appropriations, the Congressional Budget Office did an estimate of the costs of Bush’s budget proposals from 2004 through 2013 using a number of supply-side models. The final report is at http://www.cbo.gov/doc.cfm?index=4129&type=0 . Table 16 shows that all of the models showed a significant cost. The estimates ranged from $2.2 trillion to $3.0 trillion. To my knowledge, the CBO was never asked to do another projection using supply-side models. Some supply-siders complained about some of the details of how it was done but never asked for another study. Hmmm, I wonder why?
Response to comment # 2:
1) I stand corrected on when the capital gains tax occurred. But didn’t the revenues for capital gains increase after the cut? Isn’t that evidence of a tax cut paying for itself?
2) You are correct I don’t have the time to go through myriad calculations but I do my best with what time I do have. Given that, Reagan cut taxes in the 80’s. Yes, they have come up since but not as far as was the case in the 70’s. Let’s try an experiment. If we held expenditures to the inflation rate since Reagon took office and cut taxes, would we have a balance budget today?
3) The argument that taxes grow when economy grows is a tautology. The question is why does the economy grow? Reagan cut taxes, reduced regulation and stagflation became history. Do you honestly believe raising taxes in the 80’s would have increased revenues?
4) If you think cutting taxes never increase revenues then why not just tax us at 100%?
Respones to comment #5:
I think there is a ton of evidence about the effect of higher taxes. Look at Western Europe the last 40 yrs, the Soviet Union, China prior to economic liberalization, Cuba, etc. Socialist countries engage in high taxation. Look at the results. Doesn’t microeconomics teach us that lowering a price on a good CAN increase revenue?
Response to comment 3:
Yes, there maybe times for a tax increase but since when does the gov’t need an excuse to increase taxes? Your analysis of Reagan, Bush2 and Clinton leaves out expenditures. Reagan had a democratic congress which like to spend plus the need for a defense build up plus an S&L crisis on the books. Bush2 has been on a spending spree as well (not blocked by the Democrats who wanted to spend even more). Clinton had a Republican congress that limited the growth of spending. I could argue the restraint in spending is a major cause.
response to #5:
I admit I’m fuzzy on this part. But hasn’t the CBO done numerous studies on forecasting the level of the deficit? How accurate has it been? I thought they missed the deficit numbers rather badly in the near past as the economy has grown beyond their expectations. Again, I admit I don’t know this for sure but I thought that was the general gist of it.
If you don’t think tax cuts help generate growth, how do you explain the 80’s (Reagan), the 60’s (Kennedy) and the 20’s (Coolidge)?. If you were betting on economic growth, do you put your money on Western Europe or Ireland and Eastern Europe where they are cutting taxes? How did Hong Kong become an economic juggernaut in the span of a couple of generations? High taxes?
Finally, doesn’t the IMF tie lending to following the prescription of high taxes? What has been the result?
One final note to:
Tax cuts never pay for themselves? From the Reagan tax cuts in 1981 to now (yes taxes have gone up, but not to the levels of the 70’s) if we had held expenditures at 4% year (I assume close to inflation until recently) we would have a suplus of 663 billion for this year. At 5%, the surplus would 79 billion. Yes, tax cuts don’t pay for themselves if you choose to spend like drunken sailors on leave
Question for BDavis:
You state that the 70’s did not have higher tax rates and you point to numerous tax cuts the reduce the incidence of bracket creep. I guess my question is, were the 70’s marginal tax rates higher or lower than 80’s? I thought that was the whole point of the tax cuts of Reagan; to reduce the marginal rates (sometimes as high as 70%). How can the 70’s not be a high tax climate?
I apologize to Mr. Davis for my incorrect gender guess. Jeffrey, I agree that federal spending is a big part of the equation, but doesn’t it just make sense to cut spending BEFORE cutting taxes? If I were to get into a debt situation, would I look for ways to cut my income in order to get out of debt? No, I would cut my expenses and/or look for a way to increase income. Pete Peterson, in his book entitled “Running on Empty: How the Democratic and Republican Parties Are Bankrupting Our Future and What Americans Can Do About It” states that the Democratic Party can accurately be accused of supporting tax and spend policies. However, tax and spend is sustainable. What is not sustainable is spend and don’t tax, which is what we have been up to of late. Don’t tax and don’t spend is also sustainable, but politicians have found that promising tax cuts is easier than standing for fiscal restraint and a balanced budget. Supply-side economics seems to be their favorite subterfuge that allows them to claim their pandering is really good economics.
Jeffrey wrote:
1) I stand corrected on when the capital gains tax occurred. But didn’t the revenues for capital gains increase after the cut? Isn’t that evidence of a tax cut paying for itself?
No. Revenues were increasing with the rising stock market BEFORE the capital gains tax cut and they continued to increase with the rising stock market AFTER the tax cut. Then they crashed with the crash in the stock market in 2001 with no changes made to the capital gains tax rate. Obviously, the key factor in their level in this case was the stock market. I’ve posted much more information on capital gains at http://usbudget.blogspot.com/2008_04_01_archive.html .
2) You are correct I don’t have the time to go through myriad calculations but I do my best with what time I do have. Given that, Reagan cut taxes in the 80’s. Yes, they have come up since but not as far as was the case in the 70’s. Let’s try an experiment. If we held expenditures to the inflation rate since Reagon took office and cut taxes, would we have a balance budget today?
As I said here,
most expenditures need to grow at the rate of inflation PLUS the rate of population growth to remain the same per capita.
3) The argument that taxes grow when economy grows is a tautology. The question is why does the economy grow? Reagan cut taxes, reduced regulation and stagflation became history. Do you honestly believe raising taxes in the 80’s would have increased revenues?
Unlike some supply-siders who seem to be in favor of any tax cut at any time, I am not in favor of any tax hike at any time. I would like to see us bring our budget into closer balance so that we are not leaving a debt bomb for the next generation. Then I think we should leave tax rates and spending levels (corrected for inflation and population) alone unless and until we can reach a consensus to change them in a balanced fashion.
4) If you think cutting taxes never increase revenues then why not just tax us at 100%?
Yes, we all know that there are no revenues at zero or 100 percent taxation (except for those who will work for free). But, as every economic study I’ve seen (one or two of which I’ve posted here) concludes, every real income tax cut has had a cost. If you know of an economic study that purports to show otherwise, please post a link to it.